Valuation and Financial Analysis of Tesla

Is Tesla overvalued?

1. Introduction

Tesla Inc, an American automaker, energy storage company was founded by Martin Eberhard and Marc Tarpenning in 2003 based in Palo Alto, California. Intentionally departed from traditional automakers, Tesla specializes in designing and manufacturing high-performance fully electric vehicles, energy storage battery and residential photovoltaic panels.

The
first product with lithium-ion battery cells the company manufactured is The
Roadster. And then the company keeps rolling out new
features of on-going products: Model S, Model X and Model 3, which are
exceeding the imagination of its customers. Model S is the
best-selling product with global sales of over 197,600 units between June 2012
and September 2017, followed by the Model X.[1]

On 29^th June 2010, Tesla launched its Initial
Public Offering on Nasdaq at a price of $17 per share and raised $226million in
total, which makes Tesla the first American automaker company to achieve this
after Ford Motor Company (1956). Since then, the share price of Tesla has
skyrocketed to around $320 as of 31^st October 2017. Even
its CEO Elon Musk said, ‘It’s higher than we have the right to deserve’.

Tesla’s share price reaction to key events

2. ANALYSIS

2.1 SWOT Analysis

(S)trength

Leading Position in the Pure Electric Vehicle Market: Tesla is delivering innovative new technologies to transform the way we drive. Tesla’s biggest advantage lies in its technical capacity, it has several automotive design and battery technology patents, as it invested over 17% of revenues in the Research & Development Department. Although Tesla is not the only automaker that offers electric vehicles, it plays a leading role in the market for luxury, long-range electric automobiles, which is distinct from the market for luxury gas-powered vehicles.

(W)eakness

The weaknesses of Tesla mainly lie in two aspects. On one
hand, compared with traditional cars, Tesla’s ability to undertake the risk is
relatively lower. Once there are slight ups and downs in the demand for
electrical cars or production delay occurs, Tesla will probably suffer a huge
loss. On the other hand, Tesla Model S occurred fire 6 times by the end of 2014
due to the battery safety which is below public standard. The potential battery
hazard will cause adverse influence on Tesla’s market capitalization. In
addition, the popularization of charging stations in many areas need further
development, of which the process may take several years to implement. In other
words, as the significant foundation of Tesla’s development, the supportive
infrastructure is insufficient so that cannot attract more potential consumers
and the sales amount will be largely limited.

(O)pportunities

The electric vehicles market has experienced a significant
growth over the past years since in many countries the local government
encourages the usage of the environmentally friendly vehicles. For example, in
Netherlands and Norway electric vehicles enjoy reduction on registration and
circulation taxes, as well as privileged access to bus lane. Therefore, Tesla’s
high concentration on
electric vehicles market is more likely to promote profitability.

(T)hreats

As the electric vehicle market is a fast-growing market,
more and more automakers are producing environmental friendly vehicles, which
will decrease Tesla’s market share in the electric vehicle industry. Although
Tesla plays a leading role in the electric vehicles market, in terms of size
and awareness it is far from other automakers like BMW, Porsche. The general
automotive industry is always highly competitive. Under the current
circumstance, electric vehicles must compete within the entire automotive
industry. Compared to the pure Electric Vehicles, people are more inclined to
choose the hybrid electric since customers are also concerned about the range
and the charging times of their batteries. These potential issues will
adversely affect market share for the electric vehicles. Therefore, Tesla is competing
within the whole automotive industry. High industrial competition would
probably result in price reductions and potential losses, which could harm
Tesla as it does not have the economy of scale that the other manufacturers
have.

From the SWOT analysis, it could be indicated that the demand for Tesla will be largely limited in the current situation due to high industrial competition, insufficient charging stations infrastructure and its potential battery hazard despite of its strengths and opportunities mentioned above. Therefore, low demand will result in decreased prices, which could indicate the overvaluation of Tesla.

2.2 Comparable Analysis

In contrast to the
absolute valuation model such as dividend discount model and discounted cash
flow model, the relative valuation model compares the company’s price multiples
or ratios to a benchmark or other similar companies to determine whether the
company is relatively undervalued or overvalued. We think the relative
valuation model is more suitable to evaluate the valuation of Tesla, because
Tesla has no dividends and its net income and free cash flow both are always
negative (Morningstar 2017). The financial data information is acquired from
Morningstar that is shown in the Exhibit 1. We will evaluate if Tesla is
overvalued through by the comparison with benchmark and the comparisons at each
sector with other companies.

2.2.1 Benchmark comparable

The
price to sale ratio (P/S) is most relevant when used to compare companies in
the same industry. A low ratio may suggest that the company is undervalued,
while the ratio which is significantly higher than the average may indicate as
overvaluation. Table 4A shows that Tesla’s P/S ratio is greatly higher than the
benchmark of S&P 500, also is far more than the industry average. The
highest ratio of Tesla has reached 13.9 in 2011, while the benchmark is only
1.2. It is eleven times larger than the benchmark. And the lowest ratio of
Tesla is at least twice as high as the benchmark.

The
price to book ratio (P/B) can be used for the company with positive book values
and negative earnings because negative earnings make price to earnings ratio
(P/E) ineffective. It is adapted to the Tesla’s situation. Likewise, a low
ratio may mean that the company is undervalued, and the high ratio may be
overvalued. It could be seen in the table 4B that the P/B ratio of Tesla is
extremely higher than the benchmark of S&P 500. The gap of P/B ratio
between Tesla and benchmark is greater than the extent at P/S ratio. Two
highest ratios of Tesla have severally attainted at 31.1 and 32.8 in 2012 and
2013, while the corresponding ratio of benchmark are 2.1 and 2.6. Tesla’s
lowest ratio is 10.2 in 2010, which is five times as high as the benchmark.

Price/Book ratio compared with S&P 500

Tesla’s
P/S ratio and P/B ratio are both significantly higher than the benchmark of
S&P 500. This suggests that Tesla may be overvalued. We will get through
the comparison at each sector to further confirm whether Tesla is overvalued or
not.

Tesla’s
financial data information

2.2.2 Each sector comparable

As the auto
industry has abnormally low multiples, Tesla looks overvalued compared to other
major automakers on the Price to Sales, Price to Book and EV/EBITDA multiples,
when compared to company’s like General Motors, Ford, Toyota, Volkswagen, Honda

However,
when we account for top-line growth, it is clear why the market affords Tesla
an optimistic multiple, and when we look at bottom line growth via the P/E
ratio, Tesla looks undervalued compared to comparable firms in the auto
industry, as Tesla has a very low P/E multiple

As, Tesla is being valued as a mega-cap tech firm because of its high-tech niche within the auto industry and its diversification into renewable energy, so when the company is compared to other large-cap tech firms like Apple, Google, Microsoft and Amazon, its multiples look a bit fair as we could see in the chart below that companies like Microsoft and Google have a higher Price to Sales Ratio as compared to Tesla and other big fishes in the market from these analysis we can say Tesla is undervalued when compared to the Tech industry.

The EV/EBITDA ratio is a valuation indicator that compares a company’s overall value to its operational earning power, as it specifies whether a company may be undervalued or overvalued in comparison to industry peers, as the ratio considers both, the company operational earning (EBITDA vs. Net Profit) and a company overall value indicator that also includes financial debt, cash position and minority interests which are key indicators when valuing a firm market value. (Enterprise Value vs. Market Capitalization), thus is a more precise measure than the Price-Earnings(P/E) ratio. The EV/EBITDA ratio of Tesla Inc. is significantly higher than the median of its peers (9.98). According to this financial ratios Tesla Inc.’s valuation is way above the market valuation of its peer group.

3. Institutional Investors and insider trading

We decided to
consider the recent activity of institutional investors regarding the trading
of Tesla stock. This is important due to the possibility of institutional
ownership signalling stronger fundamentals. Mutual funds, pension funds, banks
and other financial institutions make money through their ability to generate
returns through employing the use of analysts and researchers. According to a
2003 study, there was a correlation between changes in institutional ownership
and stock returns over each quarter from the years 1980 to 1994 (Gibson 2003).
Institutional ownership currently accounts for 56.87% of Tesla’s shares
outstanding. The most recent quarterly filings reveal institutional holdings
increased by 5,156,362 shares, and decreased by 15,736,105 (NASDAQ 2017). The
number of holders generating these changes were 387 increasing their position,
and 268 decreasing their position. This indicates that a smaller number of
companies and funds were making larger trades. This is a net institutional
ownership decrease of 11.37%, a sign that institutions have a pessimistic
outlook towards the company. Therefore, the latest quarterly data on
institutional investors signals the notion that Tesla is overvalued.

As well as
institutional investors, insights can also be drawn from the trades of
insiders. Company senior officers and directors have greater access to
information regarding the profitability of Tesla. Over the last three months,
there have been two open market buys and nine open market sells by Directors
and Officers at Tesla. 5,508 shares have been bought, and 56,626 shares have
been sold (NASDAQ 2017). This can be contrasted with the past twelve months,
with 2,948,726 shares bought by insiders, and 716,347. The recent shift may
indicate that the insiders of Tesla regard the past year’s increase in price
from below $200 to well over $300 has been an overreaction by the market, and a
future correction will occur. A recent 2017 study found firms which exhibit net
selling before a downgrade have significantly lower returns the subsequent year
compared to firms with net buying or no net trading by insiders (Hill et al
2017). Whilst Tesla may or may not be subject to a downgrade, the activity of
insiders is certainly valuable information to consider.

Lastly, over the
last three months Tesla has exhibited a significant positive put/call open
interest ratio. This signals that the market is bearish on Tesla stock. The
latest figure has the open interest ratio at 1.42.

As shown above,
current market interest indicates a bearish sentiment for Tesla due to a net
decrease in institutional holdings, net selling by insiders and a positive
put/call open interest.

4. Investment Recommendation

Giving an investment recommendation on Tesla Motors can be slightly
grim, as there are a few factors to be taken into consideration, For example,
the excitement around Elon Musk and the extreme amount of ambiguity about its
recent growth. The fact that Tesla is not currently paying dividends, nor has
any plans to do it in the future.  One
might suggest Tesla is an overvalued firm. However, this does not indicate that
the stock will not perform in the long-term, but it is extremely exposed to
price drops in the future. Tesla could be the leader in electric automobile
manufacturing. While now, Tesla’s stock is not a buy, it could be classified as
a hold or even something that investors should wait to capitalize on if a price
drop occurs.  In conclusion, Tesla is a
growing company that investors should kept their eyes  on. Also, one cannot forget to mention that
CEO, Elon Musk is a force to be reckoned with in the technology industry.

5. Conclusion

After extensive findings our group feels the investment into the company of Tesla Motors would be best, if one waited upon purchase. The company is highly overvalued with their stock prices. It is our suggestion to see what the future holds for Tesla. Tesla is predicted to make a huge jump within the next few years. These predictions make the investment process a gamble. In conclusion, we all can predict the country is looking for environmentally friendly transportation. Once this eco-friendly trend takes off, Tesla Motors will be the automotive company leading the pack.

Sources

[1] Cobb, Jeff (2017-01-26). “Tesla Model S Is World’s Best-Selling Plug-in Car
for Second Year in A Row”. HybridCars.com. Retrieved 2017-01-31.